Musings on leadership, management, strategy, economics, philosophy, and current affairs.

09/01/2009

(Ir)rational Pricing Strategies

Behavioral economics has always been influential in shaping managers' decisions. Findings by the behavioral economist, Dan Ariely, in his book Predictably Irrational gives three different pricing tools to managers.

1) CONTEXT:

“most people don’t know what they want unless they see it in context.”- Dan Ariely – Predictably Irrational

Offer customers three options at different price levels - the middle one being the one you want them to buy. This helps the customer to compare and decide within the context.

2) DECOY:

Decoy pricing is giving customers three choices; 1) The product you want them to buy at the price you want them to buy, 2) A slightly inferior product at a slightly lower price (the decoy), and 3) a similar product but not quite the same as what the customer wants.

You know the customer won’t choose option (3)
and you don’t want them to choose it anyway. You include this choice in
the mix for two reasons, to give the customer a third choice and to
focus the customer on the choice you want them to make between option (1) and (2).

Why do this? Ariely found that people...

“tend to focus on comparing things that are easily comparable, and avoid things that cannot be compared easily.” And remember, “people don’t know what they want unless they see it in context.”

Offering customers three choices allows them to put things in context. Ariely also surmised that decoys
help people make decisions, and his experiments showed that when faced
with a decision between two similar products people will most often
choose the slightly better product, even if it costs slightly more.

3) ANCHOR:

Ariely found that “once we buy a new product at a particular price, we become anchored to that price. But price tags by themselves are not necessarily anchors. They
become anchors when we contemplate buying a product or service at that
particular price. That’s when the imprint is set. From then on, we are
willing to accept a range of prices but as with the pull of a bungee
cord, we always refer back tot he original anchor. Then the first
anchor influences not only the immediate buying decision but many
others that follow.”

So the strategy should be to set the anchor at higher levels.

What is striking in all of the above three findings is that they contradict the conventional wisdom of value pricing, where the customer is assumed to be a better judge of value of a product or service.